Recent Events at NetJets, part 1: Why NetJets?

This is too big a topic to cover in one blog post. Let's start with the deal.

Berkshire bought NetJets in 1998 for $725 million in cash AND STOCK. Rich Santulli sold the company to Berkshire because, he said, he was being pressured by Goldman Sachs (private equity investor) to take it public. Santulli wanted to work for Buffett rather than deal with analysts, earnings pressure, and short-term profit goals - a classic Buffett deal. Buffett also offers these managers two other things when he acquires their companies: 1) the promise that he won't interfere with the way they run their businesses and 2) the promise that, like him, they can work as long as they want (beyond normal retirement age).

NetJets was earning a subpar return on capital when acquired -- the theory being that this would reverse and it would become a "toll bridge" when it built out to scale. This was not a crazy idea, even though unBuffettesque. NetJets had several features that deviated from a typical Buffett acquisition. One, it was unionized in an industry where unions have a history of being fractious. Two, Buffett himself had identified the airline industry as subject to chronic irrational competition due to an overabundance of testosterone among players who want to show they have the "right stuff." Three, airlines require constant growth just to break even. As your core fleet ages out, you must replace it with newer planes, even though the planes aren't worn out. The airline business has a pyramid-like quality that is accentuated in a luxury business. Although demographics pointed in NetJets' favor, a global economic disruption could, well, disrupt that.

Why did Buffett depart from his traditional investing practices to invest in NetJets? He had a business rationale that was not entirely off the reservation, but it got a push from several other factors. Here is my very condensed take.

> Number one, Susie Buffett switched him onto NetJets; her adoration of it convinced him of the customers' loyalty; his own positive experiences with the brand did the rest. The product is so good that he thought the business had a bigger moat (i.e., pricing power) than it really does.

> Number two, he fell in love with Santulli, a former Goldman Sachs quant dude. (Recall that until recently, Buffett's gushing over Santulli caused Santulli to be often mentioned as a potential successor, although not by me.) Buffett was so infatuated with Santulli for awhile that it was cute, or would have been if it hadn't clouded his business judgment a bit.

> Number three, there was a Goldman Sachs connection. No conspiracy theory or anything like that, but Buffett is nostalgic, and returns to safe, familiar themes. Goldman Sachs has been a talisman for him since he was ten years old.

> Number four, NetJets moved Buffett up many notches in the celebrity elephant-bumping world. This is how he met Arnold Schwarzeneggar and also his mancrush of all time, Tiger Woods (!). Santulli also got him into the legendary restaurant Rao's, and introduced him to Damon Runyonesque characters like Bo Dietl.

> Number five, Santulli, who is quite a decent guy by the way, knew how to market to the polo-playing crowd. For example, he set up the celebrity poker tournament with Buffett, which Buffett thoroughly enjoyed because it meant his fans could come and worship him. It was a nice synergy that made everyone happy.

> Number six, Buffett wants to own businesses that are the best in their class, and felt he had that in NetJets.  The quality was emblemized by the Columbus flight operations center, which Buffett liked to visit. It is a fascinating place to see if you have even the slightest techy bent. (Call a NetJet salesperson as a serious prospect and they'll take you on a trip to see it.)

> Number seven, NetJets is obsessed with customer safety at all costs, and has a "zero crash" philosophy. Buffett's way of thinking about catastrophes (we win if the world goes to hell) was mightily attracted to a business like that.

> Number eight, it seemed like a heads I win, tails you lose proposition. The world gets safer and fuel prices fall -- more people can afford fractionals and can upgrade. The world gets more dangerous and travel more unpleasant -- more rich people will fly fractional and will seek the security of NetJets.

There are probably other reasons; nothing Buffett does is ever simple. These, though, are some of the reasons why I think Buffett rationalized the economics of NetJets for so long.

Part Two next.